Dust flux, Vostok ice core

Dust flux, Vostok ice core
Two dimensional phase space reconstruction of dust flux from the Vostok core over the period 186-4 ka using the time derivative method. Dust flux on the x-axis, rate of change is on the y-axis. From Gipp (2001).

Friday, July 8, 2011

Deconstructing algos 3: Quote stuffing as a means of restoring arbitrageable latency

In a recent article Nanex has shown that quote stuffing can slow down the updating of series of stock prices, bids and asks. The article was less clear about why one might do that. There could be arbitraging opportunities.

One of the first games these clowns got into was latency arbitrage. HFTer offers a number of shares for sale at one price, and at the first sign of interest, pulls all of the offers and resubmits them at a higher price. The latency comes into play because as another player send his orders in to fill HFTer, and these orders all find their ways to the market via differing routes, each of which has a different latency (lag time)--so instead of all arriving at once, they arrive singly, giving HFTer time to pull the rest of his bids.

Early this year, Royal Bank of Canada (RBC) launched a new trading program called Thor, which was designed to avoid latency arbitrage. The gist of the program was that the system would monitor the various latencies to all the different exchanges to which orders would be routed, and artificially delayed the submission along the fastest route so that all the orders would arrive simultaneously on all exchanges. While perfection did not occur, the early claims were that the various latency would me measured in microseconds, which at the time seemed reasonable.

Presumably RBC is not the only player that has developed such software.

Now we hear that orders are being stuffed down different channels at such speeds as to change the latencies. In the Nanex article we see:
Today (June 28, 2011) between 10:35 and 11:17, algorithms running on multiple option exchanges (6 or more), drove excessively high quote rates for SPY options (and 2 or three other symbols that I haven't identified yet).  Fortunately this was a quiet trading period.  A total of about 400,000,000 excessive quotes were generated -- that is, compared and scaled to the previous day. In one 100ms period, 2,000 SPY option contracts had about 16,000 fluttering quotes (some combination of nominal changes in bid, bid size, ask, ask size) resulting in saturating/delaying all SPY options on that line. These events occurred several times per minute during the interval. If these algorithms include more symbols, or if they run again during an active market, we will see severe problems. It is shocking to see this so widely distributed across so many exchanges and contracts simultaneously.
I'm pretty sure this is not intended to be damaging to the market. The fact that it runs for short bursts on limited channels suggests that there is a particular target. A target like Thor.

Saturating the quotes on individual lines will change the time lags (latency factor) during the intervals the quotes are generated. For Thor to work properly, it has to estimate by observation the precise lag between sending an order and having it arrive on each market. Randomly changing the lags for the different lines would confound RBC's (and others) attempts at ensuring all its orders arrive on all markets at the same time.

The quote stuffing in this case is intended to be noise, and its intent is to give the latency arbitrageurs the upper hand, as it is easier to generate an immense amount of random noise than it is to formulate an anticipatory response to it in real (microsecond) time.

The only approach I can see (if this is possible) is some kind of all-or-nothing fill on your orders. So your orders arrive on the different markets at slightly different times, but they aren't triggered until they are all ready and then they trigger at the same time. Of course the arbitrageur is probably also the "market maker" and can see you trying to match up your orders prior to execution, leaving you up shit creek in any case.

I really can't see an argument for these actions providing liquidity.

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